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Home Truths

There’s many a slip between applying for a home loan and getting the first loan disbursement from a bank. Here’s a primer on the intricacies of a home loan and how to bag the right loan deal

If buying a home is a dream, home loan makes it a reality. There are a lot of middle class buyers who are opting for home loans to finance their home purchase. But how do you go about winning the best loan deal? What are the finer details you need to be aware of? Here is a primer.

Let’s begin by understanding the home loan interest rate structure. Basically, the interest rate that a bank/housing finance company charges is the cost that you pay for borrowing from the bank. Remember that different banks have different lending policies and they offer different interest rates based on various parameters that include the bank’s base rate, the amount and repayment period of the loan, the credit history of the borrower, the nature of property (whether it is built-up or a plot), the purpose of the loan (whether for buying a new home, for home improvement or home extension) among others.

Number Crunching: How Your Bank Calculates Your EMI Payout

Instalment Payment Interest Principal Balance
0       20,00,000
1 26,696.66 17,066.67 9,630.00 1,990,370.00
5 26,696.66 16,733.73 9,962.93 1,951,021.21
10 26,696.66 16,301.33 10,395.34 1,899,916.68
15 26,696.66 15,850.16 10,846.50 1,846,594.17
20 26,696.66 15,379.41 11,317.25 1,790,957.40
25 26,696.66 14,888.23 11,808.44 1,732,905.93
30 26,696.66 14,375.73 12,320.93 1,672,334.97
35 26,696.66 13,840.99 12,855.68 1,609,135.16
40 26,696.66 13,283.04 13,413.63 1,543,192.41
45 26,696.66 12,700.87 13,995.79 1,474,387.67
50 26,696.66 12,093.44 14,603.22 1,402,596.74
55 26,696.66 11,459.64 15,237.02 1,327,689.99
60 26,696.66 10,798.34 15,898.32 1,249,532.22
65 26,696.66 10,108.34 16,588.33 1,167,982.31
70 26,696.66 9,388.38 17,308.28 1,082,893.05
75 26,696.66 8,637.19 18,059.48 994,110.82
80 26,696.66 7,853.39 18,843.28 901,475.35
85 26,696.66 7,035.57 19,661.10 804,819.40
90 26,696.66 6,182.25 20,514.41 703,968.47
95 26,696.66 5,291.91 21,404.76 598,740.50
100 26,696.66 4,362.92 22,333.75 488,945.53
105 26,696.66 3,393.61 23,303.06 374,385.34
110 26,696.66 2,382.23 24,314.43 254,853.11
115 26,696.66 1,326.96 25,369.71 130,133.05
120 26,696.66 225.88 26,470.78 0.00

Shun Misconceptions

Do you hunt for a bank or a housing finance institution that offers you just the lowest interest rate? Do you believe the best home loan deal is the one that charges you the lowest interest rate? If yes, you need to think again and work up your deal-hunting skills.

The long and the short of it is that before you pick a home loan lender, don’t just compare the interest rate it charges but many other allied charges and costs on the loan too. If you’ve borrowed home loan with a lower interest rate than what is prevailing in the market, don’t assume that you have bagged the good deal. While you may have saved on your interest amount, an oversight of other factors such as hidden charges, rigidity of the lender, unfavorable terms and conditions, lack of clarifications, etc could unleash troubles for you as a borrower.

Lenders impose various other charges which you must find out. These include legal fees (that the bank pays to its legal consultants); technical charges (that the bank pays to its technical consultant); prepayment charges, etc. So do compare these charges before sealing the deal.

Check Affordability

Before you begin your home loan application process, the first thing you should do is to check whether you can afford to pay home loan EMIs. EMIs comprise comprising both principal and interest and you start repaying through EMI from the month following the month the bank starts disbursement. (See EMI calculator).

Although the bank looks at your monthly salary/income to decide how much amount you should be sanctioned, you should also do your own home work to assess your paying abilities vis-a-vis your monthly expenses. As a thumb rule, the EMI you would be paying should not exceed 40% of your income. The longer the tenure of the loan the lesser the EMI outflow. Though shorter tenure means greater EMI burden, you could repay your loan faster. Also, remember that the loan-to-value (LTV) ratio is 80-20 i.e. banks don’t finance over and above 80% of the cost of property excluding the stamp duty, registration and other documentation charges. This means you’ll have to cough up the rest 20% as well as the overheads such as the stamp duty, registration etc.

Do Up Your Documents

Just because you approach a bank to lend you doesn’t mean the bank would hasten the process and dole out money to you. The bank or the housing finance company would first decide your home loan eligibility by assessing your repayment capacity, your income, age, qualifications, number of dependants, spouse’s income (if any), how much assets and liabilities you have, your job stability and bank balance history.

For this the bank asks you to furnish various documentary evidences to prove your eligibility and assess your repayment capacity. Normally, the documents required from a salaried person when applying for a home loan are namely:

  • Photograph (passport size) (two if there are two co-applicants)
  • ID proof (PAN Card) (for each applicant and each co-applicant)
  • Current residence proof (for each applicant and co-applicant)
  • Salary slips for the last 3 months
  • Bank statement of salary account of the last 6 months
  • Highest educational qualification certificate
  • Copy of the appointment letter of the current company/organisation along with the ID card
  • Form-16 of the last two years
  • Income tax return of the last two years
  • Copy of the property’s allotment letter (if buying a new home)
  • Processing fee cheque (that ranges from 0.25% to 0.5%)
  • Details of any previous loan Jugglery Of Interest Rates

Banks/financing institutions offer two types of home loans: fixed rate home loan and floating rate home loan. In a fixed rate home loan, as the name suggests, the interest rate on home loans remains constant either for the entire term of the loan or for a certain period, depending on whether the loan is on a pure fixed rate or has a reset clause whereby the bank rates may raise it after a certain period.

In a floating rate home loan, the interest rate keeps changing over the term of the loan, depending on the bank’s cost of funds, liquidity and interest rates pre vailing in the market. Also, you’ve to remember that the floating interest rate has two constituents: the index and the spread. The index/reference rate is the interest rate generally linked to government securities prices, while the spread is the extra charge that the bank charges from borrowers to cover credit risk, profit mark-up etc.

The index rate is the base rate or the minimum rate below which banks are not allowed to lend. The base rate regime was introduced in July 2010 as per the RBI’s directive to replace the flawed Benchmark Prime Lending Rate (BPLR) system. If the bank hikes its index rate it increases your interest rate causing your EMI to go up. However, some banks give the option of keeping the EMI constant, even if the base rate increases, by increasing the tenure of the loan.

Go for the floating rate if you are sure that the interest rates in the market have peaked and are going to go down. On the other hand, you should go for a fixed rate home loan if you’re sure, though it’s difficult, that the home loan interest rate won’t go down in the future. However the biggest disadvantage of fixed interest rate is that the rate is usually 1-2.5% more than the floating rate home loan.

The Devil In The EMI

Apart from the interest rate, the method your bank adopts to compute your EMI is another decisive factor of how much your EMI outgo is going to be. The method is termed reducing balance. There are two broad methods banks adopt to calculate your EMI — monthly reducing or rest and annual reducing or rest method.

In case of monthly reducing method, as the name suggests, the interest on your loan is calculated on the outstanding principal at the beginning of a month. Then the principal that is paid is deducted from the outstanding balance of the principal to get the opening principal for the next month. This process continues in the next month too — the interest for the next month is calculated on the basis of the new, reduced principal outstanding. In other words, the principal that is paid by you is set aside from the outstanding principal to be paid next month and the interest is calculated only on the remaining principal outstanding.

In the yearly reducing method, on the other hand, the principal paid is reset or reduced only at the end of the year. This means you would continue paying for the whole year interest on the principal amount that you have already paid to your lender. This way you end up paying more to the bank.

For borrowers, the EMI calculated on monthly reset is more beneficial as your principal amount is repaid faster and so the interest component keeps reducing on a monthly basis.

Written By: Sunil Kumar Singh

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